Busting the Myth That Actuarial Assumptions Drive Costs

Commentary

Busting the Myth That Actuarial Assumptions Drive Costs

In this article, Brian Septon at The Terry Group lucidly explains the flawed logic in “managing” actuarial assumptions to manage pension costs. The article addresses a common misconception that pension plans can reduce or raise costs by adjusting their actuarial assumptions. For example, it is often believed that assuming a higher rate of return reduces costs by lowering contributions, or that using newer mortality tables that reflect improved life expectancy increases costs.

Those beliefs are wrong. Assuming a higher rate of return doesn’t reduce costs if actual returns fall short of the assumption. Newer mortality tables simply recognize the reality that people are living longer and pension costs have already increased. Failing to recognize that reality doesn’t reduce costs. The truth is: “Assumptions don’t drive costs. Reality drives costs.”

While actuarial assumptions don’t change costs, they do affect the cost allocation over time. A higher than warranted assumed rate of return reduces today’s contributions at the expense of future taxpayers.

To read the full article, go here.

Truong Bui is a policy analyst at Reason Foundation, where he works on the Pension Integrity Project.